Charlemagne

A Greece or a Norway?

Cyprus takes the helm at a time of crisis for the European Union and itself

STAND on the hot, dark sand of Governor's Beach and you can take in simultaneously the troubles of Cyprus, its dream of future prosperity and its political uncertainty. The sand, sea and fresh calamari have long attracted foreigners, mostly British, but increasingly Russians who stash their money in Cypriot banks. Across the inlet stands the Vasilikos power station, destroyed last year by an explosion of munitions carelessly dumped nearby. Beyond the horizon lies the promise of bountiful undersea natural gas that could soon be piped to Vasilikos.

The explosion at Vasilikos and the banks' woes help explain why Cyprus has become the fifth euro-zone country to seek a bail-out. By a twist of fate, the troika (officials from the European Commission, the European Central Bank and the IMF) arrived in Cyprus just as the government was taking over the rotating presidency of the European Union.

From Governor's Beach, Damascus and Jerusalem are closer than Athens. Yet the (Greek-Cypriot) republic, with a population of only 850,000, will be running the EU's ministerial business for six months. Brussels frets over the prospect. Many think Cyprus should not have been let in before striking a deal to reunite the Turkish-Cypriot north with the internationally recognised south. The EU's relations with NATO are paralysed by the dispute. Those with Turkey were testy even before Cyprus took the chair: now they will be partly frozen.

There is another reason to worry. As the German tabloid Bild put it pithily: “A bankrupt island takes over power in Europe.” Can a Communist president, Demetris Christofias, handle both bail-out negotiations and the acutely difficult process of euro-zone integration imposed by the crisis? Can a debtor deal impartially with creditors' demands for stronger centralised controls? Luckily, perhaps, the rotating presidency has lost much of its importance since the 2009 Lisbon treaty. Summits and foreign ministers' meetings have their own permanent presidents, as do meetings of euro-zone finance ministers.

Cypriot ministers insist that they can do the job as well as anyone else. Diplomats argue that the country's civil service has inherited the competence of British colonial administrators. But that reputation was severely damaged by the explosion at Vasilikos. Almost 100 shipping containers packed with gunpowder and other military equipment, seized from a ship bound from Iran to Syria in breach of a UN embargo in 2009, had been piled up at a naval base for more than two years. When the cargo blew up, killing 13 people, about half the south's electricity production was wiped out, pushing an already stagnant economy into a second recession. The damage to the plant is being repaired, turbine by turbine, with full power expected to be restored by next year. But the economy will take longer to fix. Excluded from bond markets last year, and with a short-term loan from Russia fast running out, Cyprus had to ask for help.

For Vassos Shiarly, Cyprus's finance minister, it is not just the explosion at Vasilikos that triggered the crisis. “There was a financial nuclear explosion in Greece and we were one of the first to be hit by the blast,” he says. Cyprus's banks were heavily exposed to the Greek economy. And they suffered big losses, equivalent to 25% of Cyprus's GDP, says Mr Shiarly, when the euro zone imposed “voluntary” haircuts on Greece's private bondholders.

Yet Cyprus cannot blame all its troubles on accidents and outsiders. Its economy was growing steadily until the outbreak of the global financial crisis. But the boom was unsustainable. A long-running current-account deficit gaped ever wider. A small island economy can expect to buy most of its needs from abroad. But tourism and services have not kept up with rising imports, not least the ubiquitous Mercedes cars clogging Nicosia's roads. Companies and households are hugely in debt. And government debt is rising due to overgenerous civil-service pay and benefits (including index-linked pay rises twice a year). Some of this has been financed by bank deposits from Russia, Ukraine and Serbia. But will Cyprus continue to be so attractive now that the troika is scrutinising the banks and the euro zone is moving towards centralised bank supervision?

The new smell in the air

Even so, Mr Shiarly sees a bright future. “Every day that passes is a day closer to the day when we will be smelling natural gas—and the smell is beautiful.” He says Cyprus should be bringing in its own gas by 2017, and exporting it two years later. Cyprus is already studying how Norway operates its sovereign-wealth fund to manage hydrocarbon riches for future generations.

In an ideal world the discovery of gas in the eastern Mediterranean would provide a spur to co-operation in a conflict-ridden region. Northern Cyprus might have an incentive to agree to share in gas revenues; Cyprus might strike a deal to link up to Turkey's existing pipelines to Europe. Instead the gas may heighten tensions. Turkey disputes Cyprus's right to drill in parts of the sea and has been sabre-rattling. Israel has yet to delimit its economic zone with Lebanon. Turkey's bust-up with Israel has pushed the Jewish state closer to Cyprus. This marriage of convenience could become a more permanent union if, as some expect, Israel decides to export gas through Cyprus. The leading option is for the gas to be liquefied at Vasilikos.

Gas is changing the geopolitics of the region. If things go well the eastern Mediterranean might be a smaller North Sea, a safe source of energy for Europe. If they do not, it could become a mini-Gulf, a zone of instability on Europe's borders. Sooner rather than later, the EU must think of Cyprus not just as a political nuisance and an economic burden, but as a strategic interest. Time for Europe to wake up and smell the gas.